The risk of contract-based pensions

Offering a contract-based pension may seem like an easy option, but shouldering only minimum responsibility could store up problems for the future, says Helen Pridham

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On paper, an employer choosing a contract-based pension scheme must do little more than provide a suitable stakeholder plan or group personal pension.

In the long term, employers that only provide minimum risk, could face future staff complaints.

Employers can now promote their pension schemes but should be wary of giving individual advice.

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Since 2001, virtually all employers have had some responsibility for their employees’ pension provision. For those that did not already provide all employees with access to a pension scheme, it became compulsory in October 2001 to offer a stakeholder pension scheme in organisations with five or more employees. Since then, many employers have switched from defined benefit pension schemes to contract-based schemes, such as stakeholder plans and group personal pensions (GPPs).

With stakeholder plans, employers are largely free to decide their level of involvement in running the scheme. This can range from simply meeting their legal responsibilities and designating a suitable scheme to establishing an informal committee to oversee it.

While employers can make contributions for staff, these are not a requirement with stakeholder. Only if a GPP is provided must employers contribute a minimum of 3% of salary. However, employers that do no more than meet the minimum requirements may face problems in the future. Tony Morgan, head of flexible benefits at KPMG, points out: "In the United States, there are cases of ex-employees taking employers to court on the grounds they were not informed of the importance of a pension."

Yet employers that have wanted to encourage employees into company schemes have so far been reluctant to do so in case it was seen as giving financial advice. In response, the government is relaxing the rules so employers can promote their pension more actively.

But organisations will still have to be careful. Helen Buchan, sales director for corporate business at Legal & General, says: "Employers will have to ensure that staff who provide pensions information are competent."

The information they provide will also have to be generic rather than individual advice, for example, about how much an employee should save or which investment funds they should use. But ignoring these issues altogether may not be a good idea either.

Adrian Boulding, pensions strategy director at Legal & General, points out: "Where employers offer matching contributions, the majority of employees choose the ceiling, 3% where it is 3% [or] 5% where it is 5%. So in a way, employers are conditioning the amount staff save. Similarly, we find that 75% to 80% of employees opt for the default investment fund within a stakeholder, which implies they are not really thinking about their choice."

This is why communication and education are important. Simon Davies, principal consultant, pensions at KPMG, explains: "Employees should be made aware that matching contributions do not necessarily mean they will get an adequate pension at retirement." He points out that employers that do no more than provide a stakeholder scheme should get new employees to sign that they have been informed about the pension and decided not to join.

Ideally, employers should have a hands-on approach. Kevin Painter, European partner at Mercer, argues: "If they are contributing to the scheme, it makes sense to monitor its progress and make sure it is meeting their objectives." And employing trustees to run a contract-based scheme can make for an easier life.